When Securitization Blew Up; So Did the Economy By Mike Whitney

[Joanne98]

By Mike Whitney
March 04, 2009 “Information Clearing House“

“Nothing we do for banks is for banks. It’s all for the benefit of the people that depend on banks — the businesses, the families, the students — that require credit in order to do things that are important to their future.” Treasury Secretary Timothy Geithner PBS Jim Lehrer News Hour

One thing is certain, this isn’t a normal recession. In a normal recession aggregate demand declines, economic activity slows, and GDP shrinks. While those things are taking place now, the reasons are quite different. The present slump wasn’t brought on by a downturn in the business cycle or a mismatch in supply and demand. It was caused by a meltdown in the credit system’s central core. That’s the main difference. Wall Street’s credit-generating mechanism, securitization, has broken down cutting off roughly 40 percent of the credit that had been flowing into the economy. As a result, consumer demand has collapsed, inventories are growing, and manufacturing has contracted for the 13th consecutive month. The equities markets are in freefall and all the economic indicators are pointed south. The so called “shadow banking system” which provided wholesale funding for mortgages, car loans, student loans, and credit card debt, has stopped functioning entirely.

Journalist David K Richards describes the modern credit system in his article “Humpty Dumpty Finance”:

“To begin, it is important to recognize how Wall St. has transformed the bank-based credit system, which existed in the 1930’s and prevailed until the mid-1990’s, into the ‘modern’ securities-based credit system we have today. Non-bank sources currently supply more than half the credit needs of businesses and consumers. This transformation in the way credit is supplied has made it difficult for the Federal Reserve to reignite credit growth through massive expansion of the Federal Reserve balance sheet, which was the supposed 1930’s style antidote. The old-style banking system, in which banks kept the loans they made on their balance sheets, would have responded quickly to Bernanke’s interest rate cuts and aggressive injections of excess reserves. But banks today no longer keep most of the credits they underwrite on their own balance sheets, nor do they keep them in the form of individual loans. Instead, banks gather credits together to form asset-based or mortgage-based bonds which they then distribute or sell to pension funds, insurance companies, banks, hedge funds, and other investors worldwide. (”Humpty Dumpty Finance” David K Richards, Huffington Post)

This new “securities-based” credit system emerged almost entirely in the last decade and had never been stress-tested to see if it could withstand normal market turbulence. As it happens, it couldn’t survive the battering. The market for mortgage-backed bonds and other securitized investments disintegrated at the first whiff of grapeshot. As soon as subprime foreclosures began to rise, investors fled the market en masse and securitization hit the canvas. Now the wholesale funding for MBS and other consumer loans has slowed to a trickle. That means that housing prices will continue to crash dragging the stock market along behind.

The Fed and Treasury are determined to revive securitization. They’re planning to provide $1 trillion for the so-called “public-private partnership” and the Term Asset-Backed Securities Loan Facility (TALF). The money is a taxpayer-provided subsidy for a deeply-flawed system which is inherently unstable. Consider this: subprime mortgages were only defaulting at a rate of 6 percent when the entire market for securitized investments folded like a house of cards. The Fed and Treasury are wasting their time trying to fix a dysfunctional system instead of focusing on debt relief for underwater homeowners and struggling working people. That’s where the money needs to be spent.

It’s no surprise that the banks were big players in the securitization racket. Converting mortgages and other debts into securities has many perks including transfer of risk, a reduction in funding costs, lower capital requirements and additional liquidity. Banks can actually create a security and then sell it to itself at a profit in what amounts to an “in house” transaction. Nice trick, eh? There are also considerable benefits from maintaining off-balance sheets operations which–through the magic of modern accounting–allow loans to be held as assets that don’t require the same capital reserves as conventional mortgages. All this sleight-of-hand increases the amount of credit that banks can balance on smaller and smaller morsels of capital.

The financial sector now represents 40 percent of GDP, which is to say that the exchange of paper claims to wealth is the driving force behind economic growth. The production of useful things, that actually improve people’s lives and raise the standard of living, has been replaced by the trading of complex debt instruments and opaque derivative contracts. Securitization is at the very heart of Wall Street’s Ponzi-finance scam. It creates profits by transforming liabilities into “cash flow” which can be sold at market. Bottom line: Factories and manufacturing are out. Toxic paper and garbage loans are in.

Continued>>>
http://dandelionsalad.wordpress.com/2009/03/04/when-securitization-blew-up-so-did-the-economy-by-mike-whitney/

[AdHocSolver]

1. This fraud was made possible by repeal of the Glass-Steagall Act and other banking regulations.

Glass-Steagall and similar laws were New Deal regulations designed to prevent the kind of clever frauds perpetrated during the 1920's that led to economic collapse and the Great Depression of the 1930's.

Final repeal of Glass-Steagall was instigated by the likes of Robert Rubin and signed into law by Bill Clinton. Rubin went on to a directorship in Citicorp/Citigroup or whatever they call themselves now.

Glass-Steagall and similar laws made these scams illegal. Repeal decriminalized theft.

[AdHocSolver]

2. Rather than contribute to more fraud, we should reinstitute New Deal banking regulations. n/t